Mergers Might Not Signal Optimism

A boom in mergers and acquisitions usually signals confidence in the economy, and recent headline-grabbing deals evoke images of chief executives and directors cheering about their business prospects and overall growth.

So far this year, deal-making activity in the United States has topped $775.8 billion, up nearly 50 percent compared with figures in the period last year, just behind deal volume in 2007, according to Thomson Reuters. A steady parade of multibillion-dollar deals have been announced: Charter Communications’s $55 billion acquisition of Time Warner Cable, Teva Pharmaceuticals’s $40 billion hostile bid for Mylan and Avago Technologies’s $37 billion takeover of Broadcom are among them.

But in contrast to previous merger booms, this recent spate of deals shouldn’t necessarily be considered a barometer of a healthy economy. If anything, it might be an indicator of the troubles that lie beneath an overheated stock market.

In many cases, companies are pursuing takeovers not because they are excited about a growing economy, but because their own growth prospects have waned.

The numbers tell the story: Revenue growth at United States companies has declined every year for the last five years, to about 5 percent now from 11.2 percent in 2010, according to a report by Citigroup. The bank put the problem bluntly: “Many companies will therefore require a source of inorganic growth to meet analyst revenue projections.”

If you can’t build it, then maybe you can buy it.

Mergers and acquisitions have always, to some degree, been a way for companies that are struggling to grow to purchase revenue. But top-line growth for most American companies has been particularly hard to come by in recent years, and to the extent that businesses have been able to continue to increase their profits, it’s been largely a function of cutting costs. That differs significantly from other economic rebounds in which merger volume has tracked increases in revenue.

According to the Citigroup report, “strategic actions, such as M.&A. and asset restructurings, have become a key priority to generate growth in the current environment. The lack of an organic impetus to growth is apparent in the outlook for capital expenditures.” The report said “globally, growth in capital expenditures rose sharply from 5 percent in 2010 to almost 19 percent in 2011 following the financial crisis but has decelerated every year since, reaching 4.6 percent in 2013. Over the next 12 months, the forecasted capital expenditure growth is below 2 percent globally.”

Even among the current crop of deals, there is little expectation of huge jumps in revenue growth. Charter Communications’s news release for its deal with Time Warner Cable was completely devoid of any revenue projection, as was Avago’s announcement of its deal for Broadcom.

Indeed, cost-cutting continues to be one of the chief rationales in recent deals. “Synergy,” an overused word in deal-making, has returned as “savings.”

Companies also may be turning to deals as buying back shares, another method for managing earnings per share, runs its course.

“Tactically, repurchases may lift share prices in the near term, but in our view it is a questionable use of cash at the current time when the P./E. multiple of the market is so high,” David J. Kostin, the chief United States equity strategist at Goldman Sachs, wrote in a note to clients, referring to the price-earnings ratio. “Managements are often poor market timers. In 2007, companies allocated more than one-third of their cash use to buybacks ($637 billion) just before the S.&P. 500 plunged by 40 percent during the following year. Conversely, at the bottom of the market in 2009, firms devoted just 13 percent of their annual cash spending to repurchases ($146 billion).”

If share buybacks are becoming too expensive, does that mean acquisition prices are getting too heady as well?

Maybe.

Still, Mr. Kostin says, “Firms should focus on M.&A. rather than pursue buybacks at a time when P./E. multiples are so high.” He recommends that companies use equity to pay for deals. The problem with Mr. Kostin’s argument is that companies are sitting on trillions of dollars in cash and can still borrow money inexpensively. In all likelihood, another spurt of deals is in the offing over the summer, ahead of expectations that the Federal Reserve will raise interest rates as soon as the fall.

Shareholders seem to agree with Mr. Kostin — or are looking the other way about the potential for problems. Of 74 deals that Citigroup has classified as transformational since 2011, it found that the buyer’s stock price appreciated by 1.5 percent. “Historically, the market reaction to large M.&A. transactions has been mixed in the short term. However, since 2011, transformational transactions have been met with share price appreciation around their announcement.”

But as deal-making appears to move ahead with a full head of steam, with the blessing of investors, no one should mistake it for a vote of confidence in a robust economy.

A version of this article appears in print on , on Page B1 of the New York edition with the headline: Mergers Might Not Signal Optimism . Order Reprints | Today’s Paper | Subscribe